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The Failure Chain

Consider the Curious and Rather Grotesque Case of Gary J. Gross, a financial advisor from (where else?) Boca Raton, Fla. Gross' U4 is close to 100 pages long, and lists 35 customer complaints (33 of them settled) amassed at several firms over the last eight years, FINRA records show. An Orthodox Jew, Gross used his temple and his faith to earn the trust of prospective clients, one of whom was a Holocaust

a financial advisor from (where else?) Boca Raton, Fla. Gross' U4 is close to 100 pages long, and lists 35 customer complaints (33 of them settled) amassed at several firms over the last eight years, FINRA records show. An Orthodox Jew, Gross used his temple and his faith to earn the trust of prospective clients, one of whom was a Holocaust survivor, says Scott Silver, an attorney with Blum & Silver in Coral Springs, Fla., who defended the survivor and his wife. Gary Gross's “permanent record” on the Central Registration Depository (CRD), on FINRA's website, lists numerous alleged infractions, from churning, falsification of account statements and fraud, to recommending unsuitable investments and misrepresentation. “This case is about as bad as I've seen, absent outright theft,” says James Sallah, an attorney with Sallah & Cox in Boca Raton, who represents some of Gross' other clients and has been an attorney for brokerage customers in Florida for years. Many of the arbitration cases against Gross have been stayed because he filed for bankruptcy, although he is currently trying to withdraw that bankruptcy claim, according to Sallah. Only now is Gross being investigated by the SEC and the FBI, after losing clients tens of millions over a decade, Sallah says.

While Gross has not been charged with a crime, the 33 settled arbitration cases against him cost his former employer firms approximately $4.6 million. The last firm he worked for, Axiom Capital Management, paid roughly $3.8 million of that total, according to FINRA's BrokerCheck files. The Miami Herald reports that after analyzing the records of nearly 600,000 stockbrokers, it found that “[Gross] had more complaints against him than 99.9 percent of all brokers.” (Attempts to reach Gross, who defended himself in arbitration proceedings, were not successful. But in conversations with Herald reporters, he denied any wrongdoing, telling the paper, “These clients had investments that went down. It's that simple.”)

And yet, his record raises a serious question: Why are some brokers able to rack up piles and piles of complaints and settlements over the years without seeming to attract the wrath or discipline of regulators? In all, Gross worked for six brokerage firms during his career in the business, which began in 1993. He was never “fired,” and was “permitted to resign” just once, according to FINRA documents. Why wasn't he investigated earlier? Why didn't FINRA, the SEC or the Florida Division of Securities check him out sooner — say, after his 15th or 20th complaint? After all, several investors notified the state years ago of what they saw as his misconduct.

Ultimately, it's not strictly a regulatory matter. And Gross isn't the only one to have slipped through regulators' fingers; unfortunately, there are scores more like him.

Bad Record

In fact, the failure of the system to stop dishonest reps could be likened to the so-called failure chain of events that leads to an airplane crash. “In every plane crash, a series of failures usually occurs, any one of which [if it had worked properly] could have prevented the crash,” says Marc Dobin, a partner with Dobin & Jenks in Jupiter, Fla., who represents reps, brokerage firms and investors in arbitrations. “The airline industry calls it a failure chain.” In the brokerage industry, the analogous failure-chain lapses could include any of the following: greedy clients who pursue “too-good-to-be-true” investment returns, not understanding (or ignoring) the risks; firms' branch managers and compliance departments, who overlook telling clues of wrongdoing by top-producing advisors; and regulators, including states, the SEC and the self-regulatory organization, FINRA, who fail to adequately monitor a rep on “heightened supervision.”

Regulators say catching and removing a bad rep is not as easy as just revoking a complaint-heavy rep's Series 7 license and barring him from the industry. There is something called due process, of course. “There are sanction guidelines for barring a broker from the industry — it's the regulatory equivalent of the death penalty,” says FINRA spokesman Herb Perone. “To permanently bar an individual, the charge has to be an egregious offense, such as misappropriating funds,” he says. “A long list of customer complaints doesn't do it.”

But, in the end, attorneys and regulators acknowledge that there is actually a problem with the current system. It turns out that CRD records — publicly available for all on FINRA's “broker check” website, and designed to protect the investing public from unscrupulous, or even unqualified, registered reps — are not, in many cases, comprehensive (or even accurate) descriptions of a rep's true employment history.

For one thing, a lot of customer complaints don't make it onto a broker's record. Many disputes never go to an arbitration hearing, but are settled instead. In an attempt to recoup their losses, aggrieved clients may agree to settle with the stipulation that the broker's record will not be “marked.” They'd rather get their money back than play police. These settlements, protected by confidentiality agreements, reveal nothing about the contents of the case or the behavior of the rep. And even if the client does not agree to a settlement and a hearing is held, the panel is not required to make its findings public.

Another problem is a lack of full disclosure by the firms. Lawyers who spoke with Registered Rep., including Dobin, say the issue is how firms mark a rep's Form U4 (the qualification and disclosure history of all active registered reps) and Form U5 (a document filed by a b/d when a broker leaves the firm, which records the reason the broker left). There's too much room to wiggle — too much discretion — in what is included on these crucial disclosure documents, they say. For example, all of the complaints logged against a broker do not always show up listed on his U4, theoretically a registered rep's “permanent” public record in the CRD system. The reason: If the complaint doesn't name the broker as a respondent, the firm isn't necessarily required to report it. (Often plaintiffs' attorneys name the firm, since, among other reasons, that's where the money is, and firms are more likely to settle than reps.) “As a result, it is quite possible for a broker to have a number of complaints filed because of his conduct, but since he has not been named in any arbitrations, he appears clean,” says Sam Edwards, a securities lawyer with Shephard Smith & Edwards in Houston. (In the case of groundless client complaints, the record can be “expunged.”)

What's more, Form U5s are supposed to be used by firms to explain a rep's departure, but the quality of disclosure on U5s can vary greatly, say attorneys.

David Gaba is an attorney representing more than 200 claimants seeking a total of roughly $40 million in damages in 13 separate arbitrations against former rep Becky Engle and her four previous employers. Gaba says Engle's U5 never offered any indication of her alleged extensive compliance problems as she moved from firm to firm. That's because Engle didn't have any problems, says Engle's attorney, Gary Saretsky. Saretsky points to his client's CRD, which was clean prior to 2006. Since then, 23 customer complaints have been filed against Engle alleging unsuitability, fraud and omission of facts, and the complainants are seeking millions of dollars in damages. Engle's lawyer says these charges are baseless, and that the aggrieved clients are merely angry their investments failed.

But, in the meantime, the State of Nebraska's Department of Banking and Finance has made its own decision about Engle. It barred her from the industry in February after an investigation found she'd violated Nebraska securities laws by selling private placements to unaccredited investors between 2002 and 2006 while working at CGF Securities, a subsidiary of Mutual of Omaha, and her second-to-last employer. (FINRA is currently investigating Engle; her partner, Brian Schuster, was permanently barred by FINRA from the securities industry several months ago.) The state's investigation found that Engle had told many of the clients about the required income and asset thresholds needed to purchase the investments, but she also told them “not to worry about it, just sign,” and/or that she'd “take care of it,” according to official state documents.

Why was Engle's CRD record clean? Her former employers might not have told the naked truth on her Form U5, Gaba says.

defamation?

The lawyer argues that Engle's “bad” behavior goes as far back as 1998, despite what her official record shows. He says documents from her first firm, Kirkpatrick Pettis, where she was the top producer, indicate she was fired for being “unsupervisable.” But the U5 Kirkpatrick Pettis (KP) filed when she left in 2000 says the reason was “reduction in force.” “KP lied,” says Gaba. (Attorneys for KP were not available for comment.) Her next firm, First Union (now part of Wachovia), called KP to confirm that Engle had a clean record, says Gaba, but later found out the real reason for her dismissal — yet failed to amend her U5. By then, he says, there was plenty to add to her record: “First Union branch exam documents show she was taking checks from clients made out to her and her partner Brian Schuster, not the firm, and using non-reviewed sales materials. And it goes on,” he says. (Wachovia declined to comment.)

Further, when she left First Union after two years, her U5 said merely that her departure was voluntary. She was subsequently hired by CGF Securities, and that's where she was caught selling private placements to unqualified clients. Engle's attorney says Gaba is trying to “vilify” his client, and maintains that her U5 accurately depicted her record — any question of its validity should be directed to the firms and not to her.

In cases where there is evidence to support the allegations, why wouldn't a firm protect clients and future employers by more accurately and thoroughly filling out a departing rep's U5? The answer: lawsuits. Firm management fears being sued for defamation by the reps it lets go. And that remains the case despite a recent New York Court of Appeals ruling in Albany (called the “Rosenberg ruling”) in March 2007, which determined that firms should have “absolute privilege” to write what they please on a departing broker's U5 in order to protect the public from bad apples. (For more see, “A License To Lie?” Registered Rep., May 2007.) The ruling hasn't changed much, lawyers say. Firms apparently would rather avoid any potential costly and distracting legal hassles over U5s; it's better just to get rid of the rep, and let someone else clean up the mess. Also, disclosing really ugly stuff about a broker can get embarrassing. Clients and regulators will want to know why you hired the “bad” broker in the first place. Some lawyers grouse that regulators come down hard on firms for employing questionable reps when it's the regulators who gave them licenses in the first place.

What's more, the ruling only applies to b/ds in New York state (though many b/ds have offices there).“The Rosenberg ruling is a New York ruling, first of all. If you [are alleged to have] defamed someone in another state, it is not that clear-cut,” says Mark Roth, partner at Gaba's firm, Golbeck Roth. “Firms should still be concerned with 49 other states despite that ruling,” he says. “I counsel my b/ds to just use the facts [on Form U5], to be as dispassionate as possible, and not to hypothesize or over disclose.” Roth adds: “After all, this is someone's livelihood you're dealing with.”

Arbitrations can be particularly bad for branch managers. The branch's image, as well as its income, is at risk if the BOM gets tied up in arbitration. “Isn't it just easier for a manager to say [the rep's departure was] voluntary, and not lose two or three months of [his or her] life to a possible arbitration?” says Gaba.

FINRA doesn't comment on individual broker cases, but the regulator does acknowledge there are problems related to Forms U4 and U5. “We have publicly expressed concern about firms not being completely candid [on U5s] when they've fired someone, for fear of defamation lawsuits,” says Perone, the FINRA spokesman. “It's important that this information be available to regulators, and we continue to take that message to firms.” And yet Perone says he doesn't think the problem is widespread.

As for the failure of Form U4s to reflect the true number of complaints involving a particular rep, Perone says, “That is an issue we do have some concern about and have not come to a resolution on.” He continues, “We realize it's something that needs to be addressed.”

In fact, in October of last year, FINRA fined UBS Financial Services $370,000 for failing to report over 550 customer complaints, regulatory actions and criminal disclosures about brokers either on time, or at all, between January 2002 and December 2004. “The firm also filed late and inaccurate notices concerning the termination of certain brokers' relationships with the firm,” a FINRA release says. “As a practical matter, the violations may have hampered investors' ability to assess the background of certain brokers via BrokerCheck. They also may have compromised firms' ability to conduct background checks when making hiring decisions, reduced the ability of state securities regulators to review brokers' transfer applications and hindered FINRA from promptly investigating certain disclosure items,“ says the release.

Keeping Tabs

In the meantime, most reps are walking around with relatively clean records no matter how they've conducted business in the past. “Ninety percent of brokers in the industry have no disclosure events at all,” says Perone. “Of the rest, most have one event; 2 to 3 percent have multiple events.” A very small fraction — the problem brokers — might have a few more, he says.

And it's these few bad apples and repeat offenders who continue to sully the industry, costing clients untold millions. Regulators and securities lawyers alike say it is frustrating to watch unscrupulous reps slither around enriching themselves at the expense of the investing public.

In any case, chances are if you've been marked by customer complaints, FINRA is keeping tabs on you. In fact, you're probably on FINRA's watch list. Since the end of 2003, the self-regulatory organization (SRO) has maintained a “problem broker list,” Perone says. The list was created through a process of screening the CRDs of the industry's roughly 660,000 brokers for “several complaints over several years,” says Perone. He wouldn't provide specifics about the list, such as how many reps are on it, or what exactly they have to do to get on it. (“Precise info would give people a roadmap around it,” he says.)

Firms employing reps on the list are contacted by FINRA, which requests details about the firms' supervisory procedures. Perone says it has definitely helped FINRA thin out the ranks of bad reps: Since its creation, the list has decreased in size “by 74 percent, overall,” he says. The SRO also now makes use of other resources to keep up with and catch problem advisors earlier, such as info from the 500 to 600 branch exams it does each year, tips from other regulators and “a whole array of other considerations,” he says.

According to FINRA statistics, in 2007, 288 brokers were suspended, and 338 brokers were barred from the industry, down from 352 suspensions and 394 bars in 2006.

It's not easy to get a rep with dozens of complaints barred. Take the Gross case. After being “permitted to resign” from UBS, and reapplying for a license to work at another firm, Axiom, in 2002, Florida state regulators say they had little grounds for denying Gross a license. “We did a review of Gary Gross' complaints, and didn't find anything that we felt we could use to take action,” says Rick White, the director of the Division of Securities in Florida's office of financial regulation. “As a regulator we have an obligation to prove any allegation,” he says. “If a broker has been sanctioned by FINRA, we can use that to deny a broker a license. But if a broker just has several customer complaints from another state, say, that's not our jurisdiction. We have to investigate those complaints, and make our own case,” he says. And with 50 examiners covering 240,000 brokers, White says it only takes a few bad cases to sap his staff's resources. Florida did deem Gross enough of a worry to have him placed under heightened supervision, though. (Unfortunately, his supervisor was under investigation while he was supervising.)

Part of the problem Florida faced in its investigation of Gross, says White, was that many complainants didn't want to talk to him and his staff. Why? He speculates that many of the complainants had either settled, or were in the process of settling with Gross at that time, but he can't say for sure that's the reason why. Speaking generally though, White says it's a familiar situation — clients just want their money back, they don't want trouble. It echoes the thinking on the part of firms described by Gaba and other attorneys when deciding whether to write up a negative U5. Even if it's accurate, is it worth the trouble? Alas, the consequence is that the broker slips away, his U5 in effect whitewashed, and he goes on to another b/d, where he continues his questionable or fraudulent practices.

White says, in retrospect, Gross' registration was unfortunate, and that Florida should have checked in on him to see if his heightened supervision agreement was in effect and working. “We should have done another exam,” he says. “But we learned from that.”